GDP Update: Recovery and the Output Gap

We know that the U.S. economy has been in recovery for 15 months, but the common question is why does this not feel like a recovery. Private sector employment fell 105,000 between June 2009 and September 2010 (public sector is down an additional 334,000). Total Personal Income increased 2.2 percent in the past year (Oregon’s increased 2.3 percent), however wages have essentially been flat. Real GDP growth rates in the first four quarters of the expansion have been: 1.6 percent, 5.0 percent, 3.7 percent and 1.7 percent. This is not an especially inspiring trend and recent indications are for 2010 Q3 growth to be anemic as well at just 1.2 percent (other forecasts are closer to 1.5 percent, but in the big picture the difference does not really matter).

Given that the long term growth in the economy (real GDP) is somewhere around 3 percent, growth rates of sub-2 percent will not improve the overall economic situation and unemployment would rise. Economists have a term, the output gap, for the discrepancy between what an economy can be producing and what it actually is producing. The output gap measures the difference between potential GDP and actual GDP. The Washington Post has an interactive graphic showing the output gap and possible future scenarios based on different growth rates. Taking the latest potential GDP numbers from the Congressional Budget Office, historical GDP numbers from the Bureau of Economic Analysis and the GDP forecast from our office’s national consulting firm, IHS Global Insight, one can calculate the output gap for the U.S. economy post-WWII and also the projected values in the near future. The two graphs below illustrate potential GDP and the output gap.

Given the forecasted slow GDP growth in the near term, it will take quite a few years before the output gap is closed. Even under the optimistic scenario forecast (not shown here), the output gap does not close until sometime in the 2017-18 time period.

In 2010 Q2, the output gap was estimated to be about $889 billion (6.32 percent) which was an improvement from the estimated $1.04 trillion output gap in 2009 Q2. The largest output gap, in percentage terms and in the time period covered by the data, was 7.54 percent which was reached both in 1982 Q4 and 2009 Q2. The difference between the two recessions was the U.S. experienced fairly robust growth in the mid to late 1980s (certainly above trend growth), while expectations are for a very slow, protracted recovery today.